Refinancing a home loan is a common practice in Australia, especially when homeowners want to take advantage of better interest rates, consolidate debt, or access their home’s equity for renovations or investments. One key factor that determines whether you can refinance is the amount of equity you have in your property. Equity is the portion of your home’s value that you own outright, and it plays a significant role in determining your refinancing options.
Understanding how much equity you need to refinance is essential because it affects not only the type of loan you can qualify for but also the costs associated with refinancing, such as Lenders Mortgage Insurance (LMI). In this article, we’ll explore how equity works in refinancing, what the typical equity requirements are, and what options are available if you have less than the recommended amount of equity.
What is home equity?
Home equity refers to the difference between your property’s current market value and the outstanding balance on your mortgage. For example, if your home is valued at $1,000,000 and your remaining mortgage is $600,000, your equity is $400,000. As you make mortgage payments and as your property increases in value, your equity grows. This equity can be leveraged when refinancing to secure a better loan or access additional funds.
Equity is a crucial factor in refinancing because it helps lenders assess the risk involved in issuing a new loan. A higher amount of equity generally means you are a less risky borrower, making it easier to secure better loan terms. Most lenders calculate equity as a percentage of your property’s value, known as the loan-to-value ratio (LVR). Typically, lenders prefer an LVR of 80% or less when refinancing, which means you should have at least 20% equity in your home to avoid extra costs like LMI.
General Equity Requirements for Refinancing
In Australia, the general rule is that you need at least 20% equity in your home to refinance without incurring Lenders Mortgage Insurance (LMI). This means your loan-to-value ratio (LVR) should not exceed 80%. Lenders use this threshold to ensure that borrowers have a sufficient stake in their property, reducing the risk to the lender. With 20% equity or more, you are considered a low-risk borrower and are more likely to secure favourable loan terms, such as lower interest rates and fewer fees.
However, it is possible to refinance with less than 20% equity, though this may result in additional costs. Some lenders will allow refinancing with as little as 10-15% equity, but in these cases, you may be required to pay LMI, which can add a significant cost to the loan. LMI is designed to protect the lender in case the borrower defaults on the loan, but it is an extra expense that can make refinancing less attractive. If you have less than 20% equity, it’s important to weigh the benefits of refinancing against the potential costs.
How to Calculate Your Home Equity
Calculating your home equity is straightforward. You simply subtract the remaining balance on your mortgage from your home’s current market value. For example, if your home is worth $800,000 and you owe $500,000 on your mortgage, your equity is $300,000. It’s essential to get an accurate property valuation to determine your home’s true market value, as this will directly affect your equity. Many lenders require a formal valuation as part of the refinancing process, which they typically arrange through a professional valuer.
Market conditions can also affect your property’s value and, consequently, your equity. If property values in your area have increased since you purchased your home, your equity may have grown, even if you haven’t made extra repayments. Conversely, if property values have declined, you may have less equity than expected. Keeping an eye on the local real estate market can help you better understand when it’s a good time to refinance based on your equity.
The Role of Lenders Mortgage Insurance (LMI)
Lenders Mortgage Insurance (LMI) is a cost that applies when borrowers have less than 20% equity in their home. While LMI protects the lender in case the borrower defaults on the loan, it is the borrower who pays for it. The cost of LMI can be substantial, sometimes amounting to thousands of dollars, depending on the size of the loan and the borrower’s LVR. When refinancing, LMI becomes a factor if your equity is below the 20% threshold.
The primary purpose of LMI is to mitigate the risk for lenders when issuing loans to borrowers with less equity. If you’re refinancing with an LVR of more than 80%, you’ll need to account for LMI in your calculations to determine whether refinancing is financially beneficial. However, if you have built up more than 20% equity, you can avoid LMI altogether, making refinancing a more cost-effective option.
Refinancing with Less Than 20% Equity
Refinancing with less than 20% equity is possible, but it comes with certain trade-offs. Lenders are often willing to consider refinancing for borrowers with 10-15% equity, but this usually involves paying LMI or accepting higher interest rates. While LMI adds to the overall cost of refinancing, it might still be worth considering if you can secure a better interest rate or loan features, such as an offset account or the ability to consolidate debt.
Additionally, some lenders may offer special refinancing products designed for borrowers with less equity, but these often come with stricter terms and conditions. If your goal is to access better loan terms or release equity for other financial goals, it’s important to carefully assess whether refinancing with less equity makes sense in the long run. A mortgage broker like Eden Emerald Mortgages can help you compare options and find the most suitable loan for your circumstances.
Accessing Equity Through Refinancing
One of the key benefits of refinancing is the ability to access the equity you’ve built up in your home. This is often referred to as an equity release or cash-out refinance. If you have sufficient equity, refinancing allows you to borrow against your home’s value to fund renovations, invest in other properties, or cover significant expenses such as education or medical bills. To access this equity, most lenders require that you maintain an LVR of no more than 80% after the refinance, meaning you can only borrow up to 80% of your home’s value.
For example, if your home is valued at $700,000 and you owe $400,000 on your mortgage, you have $300,000 in equity. If you refinance, you could potentially borrow up to 80% of your home’s value ($560,000), meaning you could access up to $160,000 in equity. This equity can be a powerful tool for achieving your financial goals, but it’s essential to use it wisely and ensure that you can comfortably manage the repayments on your refinanced loan.
Factors That Can Affect Your Refinancing Eligibility
While equity is an important factor in refinancing, it’s not the only consideration lenders look at when deciding whether to approve your application. Your credit score, income stability, and debt-to-income ratio all play significant roles in determining your eligibility for refinancing. A strong credit score and consistent income make you a more attractive candidate for refinancing, as they signal to lenders that you can meet your new loan repayments without issue.
Additionally, the current value of your property will affect how much equity you have and, in turn, your refinancing options. If property values in your area have decreased, you may have less equity than expected, which could limit your ability to refinance. Lenders will also consider your overall financial health, including your ability to service the new loan. Ensuring that you are financially stable and have a solid credit profile can improve your chances of securing a favourable refinancing deal.
Conclusion
When refinancing in Australia, having sufficient equity is crucial to securing the best loan terms and avoiding additional costs like LMI. Typically, lenders prefer that borrowers have at least 20% equity in their property to refinance without incurring LMI, as this reduces their risk and opens up better loan options. However, refinancing is still possible with less than 20% equity, though it may come with higher costs and stricter terms.
Before refinancing, it’s important to calculate your home equity accurately and assess your financial goals. Whether you’re looking to reduce your interest rate, access equity for investments, or consolidate debt, ensuring you have enough equity can make the process smoother and more financially beneficial. Seeking advice from a top mortgage broker like Eden Emerald Mortgages can help you navigate the refinancing process and find the best option based on your current equity and financial situation.